Wednesday, March 31, 2010

Patents are supposed to cover inventions, so it would seem that the DNA of a naturally occurring living organism shouldn’t be able to be patented. The U.S. patent office, though, has been granting an exception to that based on a court ruling that allows “isolated” gene sequences to be patented. The new court ruling suggests that the patent office has misinterpreted the earlier ruling, which is meant to apply only an active product made from a physically isolated gene sequence. The routine laboratory activity of looking at, or testing, specific gene sequences is not what is meant by “isolating” them.

If this ruling stands up on appeal, as I expect it ultimately will, it will invalidate all patents on naturally occurring genes. This means scientists who discover important gene sequences will not be able to gain a copyright-like protection of those gene sequences by using the patent process. It also means that a new genetic test must involve a novel, non-obvious testing procedure to be patentable. You can’t patent a gene test you design if it uses industry-standard techniques and the only thing that is “novel” about it is the specific genes you are testing.

If genes are not “novel” in the legal sense and cannot be patented, it will open the door for more vigorous research into medical conditions. Many diseases have genetic components, but gene patents have prevented scientists from looking into these connections. Now, it appears, scientists will be free to investigate the genetic components of any disease they might be studying.

Tuesday, March 30, 2010

The jury is in. It is the end of the line for Unix — and Linux has prevailed in its most serious legal challenge to date.

The decision a jury made today was that the contract by which Novell sold development rights in Unix to SCO did not transfer any software copyrights to SCO. Most of the world has known this for about seven years — after all, the original contract, as vague as it was about some other things, was very specific about excluding copyrights — but it is now, finally, a legal fact.

This means that SCO spent a decade suing and threatening computer users for supposedly copying something that it never owned in the first place. It apparently means that Microsoft and Sun Microsystems paid SCO to license software that SCO didn’t own. It means that SCO never had a legal basis for its claim that Linux is a copy of Unix, because the Unix components that supposedly were copied into Linux were never owned by SCO in the first place.

For SCO, this is the end of the company. The company has been in bankruptcy for two years, had already fired its staff, then its executives, and is selling assets to pay its accountant and other expert help. The company had been pinning its very faint hopes on a lawsuit against IBM, but the lawsuit was based on a claim of copyright infringement that will now have to be withdrawn. It’s not clear whether the remaining claim of contract violations against IBM can go forward, but even if it can, IBM’s counterclaim against SCO for contract violations is probably much larger, probably about $100 billion larger. If the case against IBM could go forward, then, the likely outcome would be that SCO, which has basically nothing left as it is, would end up owing IBM billions of dollars. I don’t think the bankruptcy court will allow that. I expect the judge in the SCO bankruptcy will order a liquidation within the next six months.

To be clear, SCO’s copyright problem was not its most serious problem it faced in its litigation. SCO signed away its rights to the software it is suing over, and its case depends on courts finding that those licenses aren’t valid. SCO also had a contract with IBM, and its case against IBM depends on that contract being tossed out. It is hard to get courts to void contracts, and it may be impossible now that SCO is revealed to be a shell of a company with essentially no legitimate assets or business. Then there is the problem of the absence of evidence. In all its years of litigation, SCO never said who copied what; its case is essentially, “We’re pretty sure someone copied something of ours.”

For Unix, it is an ignominious end, to be bogged down in a failed campaign of litigation, not just against essentially the whole world of computing, but against the truth. Unix was already fading when SCO started its litigation campaign at the beginning of the decade. Unix may be the most influential operating system in history, but the key word in that statement is history. The Internet runs on Linux, and as you may have heard, the Internet has some influence on the computer industry. In 1990, there were around 100 versions of Unix that mattered, but by 1999, there were only three. Those came from Digital Equipment Corporation, which was bought out and shut down years ago; Sun Microsystems, which appears to be facing the same fate now; and IBM, which became convinced around 2001 that Linux was a more mature and stable operating system than its version of Unix. So at this point, there are no major companies backing Unix.

The promise of Unix, in the 1990s, was of generally compatible computer operating systems from a wide range of companies, and that had already disappeared by 1999. The only hope for Unix was the possibility that a company would take it on and bring it up to date. I supposed it is a sign of how far gone Unix was already that the development rights ended up in SCO’s hands, and its fate was sealed when SCO decided to hire lawyers instead of engineers, to try to shut down Linux in court instead of competing with it.

But it’s worse than that. In the course of the SCO litigation, people have been taking a closer look at how Unix came about. It turns out that more than half of the source code for Unix System V, the first fully functional version of Unix, was taken from BSD. History books have described BSD as an imitation of Unix that was created mostly by graduate students at the University of California at Berkeley. From what we know now, it is more accurate to think of BSD as the original, and Unix as the copy. Essential ideas in BSD originated in Unix, but the imitation is larger in the other direction.

Unix may have faded away, but BSD, with its more mature, up-to-date technology, did not. In fact, it did not influence just Unix. It has also influenced core functionality found in Microsoft Windows and Mac OS X.

For computer users at large, the decision today means you can go ahead and use your computer without worrying about being sued by SCO. SCO made headlines by claiming to own a piece of Linux and threatening to sue essentially all the computer users in the world. We now know it doesn’t have grounds to sue anyone. You may proceed to browse the Internet without fear of someday having to write a check to SCO.

Monday, March 29, 2010

Don’t look now, but your unemployment compensation just ran out. That’s if you lost your job in the early stages of the economic downturn and have been unemployed for most of the time since.

The Senate was unable to vote on extending unemployment compensation because of a filibuster, which came after Republican leaders in the Senate threatened to filibuster every item of business that came before them as retaliation for the health care reform reconciliation bill. They didn’t really mean it — they have let some routine measures go by — but the idea of unemployment compensation was more than they could stomach at the moment.

I’ve been warning that there will be a lot of workers who will go jobless for six years, a scenario never before seen in the U.S. economy. And the possibility of becoming unemployed, and then having no income for a period of time, has to be putting a damper on some households’ spending plans. I expect this effect to show up in the next consumer confidence reading, even if the Senate eventually approves a compromise plan that will extend unemployment for a few more weeks. There is reason to worry that, when it comes to unemployment compensation, the patience of Senate Republicans is starting to wear thin.

Sunday, March 28, 2010

If you look at the litter along the side of the highway anywhere in the United States, it is hard not to notice that beer is disproportionately represented. Beer is a tiny fraction of everything that is manufactured and consumed in the country, but its containers provide almost half of the litter that ends up on the roadside.

The empty beer bottle tossed aimlessly at the side of the road speaks of social isolation. There is a reason the drinking driver can’t take the beer, or the empty bottles, home. Their reputations would suffer. This, of course, is very much at odds with the commercial image of beer.

In the television commercials, beer is surrounded by parties and fun social occasions. That’s a fair picture of the way most American adults approach beer, but most of the beer is going to another kind of drinker. It takes a house full of party-goers on a Saturday night to match the weekly beer consumption of one Joe Six-Pack, the serious drinker who has the potential to drink more than half a gallon on any given day or even during a single sports event. So the beer on television might be on its way to a lively social occasion, but most of the beer that comes out of the factory is going to people who will consume it furtively, the victims of a habit that they would rather not have observed — or not counted, at least.

The beer commercials are an impressive piece of misdirection, then. For the people who drink most of the beer, the everyday, serial beer drinkers, the commercials let them imagine that skulking around drinking beer is almost like going to the parties that they haven’t been invited to. And for the people at the party, the commercials are careful not to give any hint that the beer bottles they are holding in their hands are exactly like the ones that many of the real beer drinkers have left at the side of the road.

Saturday, March 27, 2010

I am seeing people paying in cash more often in commercial transactions, and for some people, it seems to significantly affect their self-image and the meaning they associate with their actions. When you pay with a credit card, you might understand that you are paying with the bank’s money, and this can lead you to feel that you have no money of your own. Many people have the same feeling with debit card payments, perhaps reflecting the very complex bank rules that surround these transactions. But almost everyone who pays in cash seems to feel that they are paying with their own money is borrowed.

For some people, the change from paying with a card to paying with cash leads them to suddenly feel rich. At the same time, it may lead them to take their spending decisions far more seriously. The self-talk seems to involve statements like these: “Look at all the money I have. I must be important. That means the way I spend money is important. I have to set a good example in the way I spend money.”

None of this makes sense in the accounting sense. You can, in theory, spend money in exactly the same way, with the same quality of decisions, regardless of the form of payment. But money is not just an accounting abstraction. Money is magic. If you discover that using money in a certain way makes you more magical, then do it that way, and don’t worry if your inner accountant argues that it shouldn’t.

Friday, March 26, 2010

Will there ultimately be an effective investigation of Wall Street? Sen. Ted Kaufman says yes. He says law enforcement targeted at financial fraud is finally well funded. Bank of America says no. It admitted this week that it has been manipulating its balance sheet with repo transactions for years to boost its reported level of assets, but insists that the way its bogus transactions were reported is perfectly legal.

The health care reform measures passed by Congress this week figure to reduce personal bankruptcies by about half by putting a cap on out-of-pocket expenses for people who have health coverage, but this won’t happen soon enough to rescue the banks. The reduction in bankruptcies may take about six years to fully take effect. In the meantime, the continuing financial stress of the economic slowdown will keep bankruptcies at elevated levels.

A new bank bailout is going on, in the form of net loss carrybacks. This tax rule, temporarily expanded by Congress last year, allows large banks such as Wells Fargo to postpone income tax payments, sometimes for years. The hope is that this will allow the large banks, and some other large corporations, some breathing room to get their finances in order. The size of this bailout for the banks: maybe $35 billion or so.

With the stock market at its highest level in almost two years, several bank holding companies this week filed papers for stock offerings, either to strengthen their capital position or for the purpose of acquiring a failed bank.

The Fed this afternoon approved First Niagara’s application to become a bank holding company. The approval is a necessary step for First Niagara’s planned acquisition of faltering Harleysville National Bank, which will make it a major presence in the Philadelphia suburbs. First Niagara filed to become a bank holding company in December after realizing that OTS would not approve the Harleysville National Bank acquisition. It said in a press release today that it hopes the remaining steps will follow in the next two weeks. Harleysville National Bank is a bank with a strong history, but got into a squeeze in 2006-2008 when its holding company spent too much money on acquisitions, including the acquisition of a local mortgage company.

Tonight was a night for small bank failures. The largest was Desert Hills Bank in Arizona, with three locations in the Phoenix area and three more an hour to the north in Prescott and Sedona, and $427 in deposits. It reported losses of $13 million over the last two years, which doesn’t sound so bad, until you learn that it had $75 million of real estate on its balance sheet as of December 31. The deposits are being moved to New York Community Bank, which is also purchasing the assets. New York Community Bank is a large New York City-based bank that prior to last year hadn’t ventured west of East Windsor, New Jersey. In December it added the 66 locations of the failed AmTrust Bank, including 12 in Arizona.

There were two bank failures in Georgia, starting with McIntosh Commercial Bank, with four locations west and east of Atlanta and $343 million in deposits. Trouble loans, mostly in real estate, made up 24% of its assets at the end of last year. Its location, on the outer edges of a metropolitan area, was particularly inauspicious for real estate projects started since 2005. The deposits and assets are being acquired by CharterBank, a much larger bank in the local area.

Northwest of Atlanta, the bank closure was Unity National Bank, with five locations and $264 million in deposits. Arkansas-based Bank of the Ozarks is taking over the deposits and purchasing the assets.

A small bank that failed in Florida was also bought out by an Arkansas bank. Key West Bank failed, with one office in Key West and $68 million in deposits, and its deposits and assets were purchased by Centennial Bank, which had raised more than $100 million in a stock issue to purchase failed banks. Key West Bank’s web site listed $11 million in foreclosed vacation homes for sale.

Thursday, March 25, 2010

A little-noticed provision in the health care reconciliation bill passed by the House on Sunday and now being considered by the Senate may make a big difference for future college students. The change eliminates the billions of dollars in paperwork fees that the federal government pays to private lenders when they lend money to college students. Although much more needs to be done to reform the student loan business, this move is a useful first step that will help keep students from getting caught up in the often predatory lending practices of the private companies that make college loans.

Many students imagine that since the loans are loosely associated with the federal government, they must be offered in a somewhat scrupulous manner, but that is not necessarily the case. Borrowers who take more than four years to complete college, or who become unemployed in the first ten years or so after college, risk running into hidden fees that can boost their college debts by a factor of two or three. If borrowers aren’t careful, they can end up owing around $1 million on college loans that had an original principle of $200,000 or so. This is more money than some of them can ever hope to pay off, with the possible result that lenders will be attaching 25 percent of their retirement checks, if they can ever retire. Student loans are bankruptcy-proof, so for some unlucky borrowers, there really is no hope of ever getting above water financially.

A lifetime of debt and impoverishment, the modern form of indentured servitude, is not what student loans are supposed to accomplish. The government pays for student loans with the idea that the education will help people improve their lives, and of course, that happens often, but not often enough. Part of the problem is that college costs too much, but clearly, the loans themselves are part of the problem also. A more substantial set of reforms are needed, but for the federal government to stop pouring billions of dollars into the paperwork for a program that is snaring thousands of teenagers every year into a lifetime of perpetual poverty — that is, at least, a step in the right direction.

Wednesday, March 24, 2010

The hotel-building flurry that accompanied the late bubble years is finally winding down. It took a long time for this to happen because planning and building a new hotel takes years and is hard to interrupt mid-stream. But a slowdown in new projects has led to a 36 percent decline in the number of hotel rooms on the way, either in planning or construction, compared to a year ago, according to a report in Hotel News Now. The decline was largest in Las Vegas, where some projects were actually canceled, creating a 75 percent decline.

The decline in hotel-building is good news for hotel operators, who have been squeezed by a sharp decline in travel that hit in 2008. Cutting rates hasn’t been enough to get people to travel again, but at least the amount of new competition will be a little less.

Tuesday, March 23, 2010

If you go by the headlines in the Chinese press, the Chinese government has succeeded in hounding Google out of the country. Google says it will try to keep its China office open, but the air of resignation in the statement suggests that the best they are hoping for is for a few more months, or perhaps just a matter of days, before uniformed officers surround the building and order everyone out.

China’s move in expelling Google — the current actions come, remember, after a highly organized network break-in to Google servers on a scale that could only have been managed by a collaboration between the Chinese central government and organized crime groups located within that country — will serve to reinforce its new reputation for aimlessness and an enigmatic approach to business regulation.

Google’s move to the friendlier confines of Hong Kong is not the only current headline that reflects a decline in China’s business reputation. Here are two others from last weekend:

“Rio” in that last headline is Australian mining company Rio Tinto, and while the Chinese government has tipped the trial as a warning to Australia, no one in China or Australia appears to be able to say what Australia is being warned about, except perhaps to be wary of China.

It is not just foreign businesses that are worried about the new direction of the Chinese government with respect to business. The Rio trial has the whole Chinese mining industry worried, and the word among Chinese business seems to be that this is a good time to hold back, keep a low profile, and hope not to be noticed — a far cry from the go-go spirit of Chinese business two or three years ago.

China’s central government appears to be worried about losing control of the country, yet both foreign and domestic businesses seem to be more than willing to cooperate with the government if it would give any clear guidance, or even any sense of direction. But the government has recently offered only vague threats, crackdowns, and retaliation with no guidance attached. Google, for example, has no idea how to respond to the Chinese government’s effort to break into its servers, because the Chinese government’s only statements have been a combination of threats and denials. I can only assume that the Chinese government really does not know where it is going, and as a result, there is a significant chance that it is going nowhere.

Monday, March 22, 2010

A U.K. government report released last week shows that recycling is still preferred for economic reasons, in addition to the environmental reasons, for most waste disposal. The report, summarized in a story in The Guardian, might surprise some people in the United States with its recommendations, which suggest recycling wood and plastic wrap, materials rarely collected from consumers for recycling in the United States.

Recycling has been supported somewhat grudgingly in the United States because of the suspicion that, when all the costs are considered, recycling may be more expensive than landfill disposal. The U.K. report took a broad look at costs, though, and considered both consumer effort in separating materials and transportation costs for recycled materials if they must be exported, and concluded that recycling works out well for almost all waste materials other than food and garden cuttings.

The report calls for more incineration for energy generation, incinerating materials such as low-quality paper and plastics that cannot be recycled, but cautions that this can be done successfully only if materials are separated from each other. The environmental advantage of incineration is that it may replace other means of electrical generation that generate more greenhouse gases.

Sunday, March 21, 2010

Whatever else may be said for tonight’s Congressional action on health care, it represents a political victory — a victory over discrimination.

Regardless of the excuses conservatives might offer for their opposition to health care, the real energy behind the opposition to health care comes from a gut feeling among many in the Republican base, a feeling that tells them that some people are inherently better and more deserving than others. To be blunt about it, what they really want, when it comes to health care, is health care for certain kinds of white people, and not for anyone else. They are so appalled by the thought of black people getting access to health care that they will vote to take health care away from their own grandchildren to keep that from happening.

This energy does not describe the majority of Republicans in Congress, of course. Republican House members are not talking openly in the floor debate about withholding health care from blacks, although astonishingly, gripes about the cost of health care for American Indians have been mentioned. But the energy of spite and division describes a significant part of the Republican base. And Republicans in Congress stand united, unanimous, in trying to impress this group — a tactical error that may only serve to hasten the decline of a party that, in Washington at least, has already made itself irrelevant by going on strike. Whatever the reason or rationale, this anger based on racial hatred is the energy that the conservatives and Republicans are trying to draw on to advance their own cause.

But — and this is the most important point — they are in the minority. After tonight’s planned votes in the House and Senate, we will be able to say that the most important policy decisions in the United States are not made on a foundation of racial hatred. We will be able to say that most Americans just want things to be fair.

There are problems in the health care bill, of course. But in the short term, the cost savings in the bill — immediately, perhaps one billion dollars per day for U.S. households and businesses, and developing over time, larger savings than this for the federal government — are essential for the economic recovery that the country is looking for right now. And with some measure of economic improvement, perhaps the other fixes that are still needed in health care will not be so hard to address.

Saturday, March 20, 2010

I have written at length about the importance of “reptilian brain,” the primitive part of the brain that is heavily involved in eating, breathing, habits, reflexes, and comfort. Scientists have known the importance the reptilian brain for more than a century, but we are just now learning the significance of the enteric nervous system, the “second brain” that is located along the intestines. Scientists always figured that this brain was involved in controlling the digestive process, and was the source of the gut feelings that so often reflect a form of wisdom that isn’t available to us intellectually. But it turns out that the brain in the gut is much more than this. A new Scientific American online story written by Adam Hadhazy outlines some of the latest information on the “second brain.”

At the risk of taking some license with the known scientific facts, I think of the “second brain” as the “worm brain.” I don’t really know how a worm’s brain works, but the shape of the enteric nervous system resembles that of a worm, so I am imagining that there are functional parallels.

It is apparent that the “second brain” has qualities that the brain in the head cannot imitate. The gut is 9 meters long. The head’s neurons are much more closely interconnected and because of this, the head comes to conclusions sooner. The gut takes longer to come to any conclusion.

The gut communicates with bacteria — the huge numbers of bacteria in the intestine, more numerous than the number of neurons in the entire human body — and it appears to draw significant information from them. There is no indication that the head has any such ability, and scientists at this point can only imagine the information that the gut receives from bacteria, and how the communication takes place.

The gut is also more involved in mental states and in diseases than was previously imagined. The Scientific American story mentions intriguing hints that depression and autism may originate in the gut. Serotonin, a neurotransmitter with profound effects on the thinking process, mostly originates in the gut, and scientists recently found a way to cure osteoporosis in rodents by inhibiting this process.

All this new information has made me more interested than I was already in the interaction between food and mood. Food surely must affect human moods in a profound way, and potentially very quickly, and mood in turn may determine many food choices. This forms a cycle that, if we are not careful, can proceed without any conscious control. Conscious control of patterns of food and mood, to the extent that we are able to develop it, would start with paying more attention to these connections.

Friday, March 19, 2010

Heads will roll — that’s my prediction of the political fallout after the disclosure of Fed bailout decisions, which I believe is on its way after a federal appeals court decision today. The decision paved the way for the release of Fed documents related to bank and other bailouts, starting in 2007. I am confident that the release of information will show that the bailouts had little or nothing to do with protecting the global financial system, which could have been accomplished with a much smaller sum of money, and everything to do with protecting Wall Street profits. I do not think this will be the end of the Fed as we know it, but there will at least have to be a serious discussion of that after the Fed actions are out on the table. None of this will happen immediately, though. There are months of legal maneuvering ahead, and the Supreme Court or Congress could still intervene to protect the Fed.

There has been another arrest of a banking executive. The former president of The Park Avenue Bank in New York City was arrested Monday and indicted on a list of charges related to the bank’s decline and eventual failure. According to the indictment, there was a scheme to use the bank’s own money to buy shares of stock in the bank, in connection with an attempt to defraud the TARP program. This is similar to the cases brought against executives of some banks that failed at the end of 2009 in Venezuela. When executives take a bank’s money and use it to buy stock in the bank, it is not just a form of securities manipulation, although that is serious enough. It is mostly a way to make the bank appear to have more capital than it has by counting some of the capital two or three times. This can make a bank that is on the verge of financial collapse appear to be financially stable, at least for a short time.

Tonight was the end of the line for Advanta Bank, the bank that was left behind when Advanta wound down its credit card operations a year ago, leading the holding company to file for bankruptcy in November. Advanta Bank was not so large in comparison to the scale of the Advanta small-business credit card operations that that was cut off from capital last year after its investment trust failed, in an early version of what is likely to happen to much of the credit card industry later this year. Advanta Bank was in litigation with its bankrupt parent company over tax credits, credits that probably would have returned the bank to a positive capital position, but which the parent company refused to take. The FDIC may want to take up that dispute in bankruptcy court, now that the bank has been closed and liquidated. Advanta Bank had also sued the FDIC, in a case that would appear to be moot now.

Advanta Bank, chartered and based in Utah, in a suburb of Salt Lake City, had $1.5 billion in deposits at the end of last quarter. It had taken about $200 million in losses on bad loans last year, with more losses sure to come, and regulators had ordered the bank to reduce the scale of its business last summer (the focus of the bank’s suit against the FDIC). The largest part of the bank’s business was collecting payments on the closed Advanta credit card accounts.

Advanta had been the title sponsor of World Team Tennis, and the professional tennis league has been hunting for new sponsors after Advanta’s last sponsorship payment expired December 31.

There is no successor bank. The FDIC will mail checks to depositors starting Monday. Despite the large size of the bank, the FDIC estimates that 99.8 percent of deposits were within the deposit insurance limits. The cost to the FDIC is estimated at $636 million.

There were three unrelated bank failures in Georgia:

Appalachian Community Bank, based in Ellijay, Georgia, with 10 offices in the area of the Georgia-Tennessee border, some operating under the name Gilmer County Bank. The failed bank should not be confused with a related bank of a similar name, Appalachian Community Bank FSB, based nearby in McCaysville, Georgia, near the Georgia-North Carolina border, which is not affected by the closure. The failed bank had nearly $1 billion in deposits. The deposits are being transferred to Community & Southern Bank, which is also purchasing the assets.

Bank of Hiawassee, with three offices along the border with North Carolina, plus one operating under the name Bank of Blue Ridge and another operating under the name Bank of Blairsville. The failed bank had $340 million in deposits. The successor is North Carolina-based Citizens South Bank, which paid a 1 percent premium for the deposits and is purchasing the assets. The holding company of Citizens South raised $15 million in a recent stock issue.

Century Security Bank, with two locations in the greater Atlanta area. The failed bank had $94 million in deposits. Bank of Upson is taking over the deposits and purchasing the assets.

The three Georgia closings are expected to cost the FDIC $587 million.

Alabama banking regulators closed First Lowndes Bank, which had four locations in the south central part of the state and $131 million in deposits. First Citizens Bank, also based in Alabama, is taking over the deposits and purchasing the assets. The failed bank had used its web site to announce its foreclosed property for sale.

The first bank failure of the year in Ohio, at closing time tonight, was American National Bank, with $67 million in deposits and one office in Parma, Ohio. The successor is The National Bank and Trust Company, also based in Ohio, which purchased the assets and took over the deposits.

Finally, in Minnesota, state banking regulators closed State Bank of Aurora. It had one location and $28 million in deposits. The office is becoming a branch of Northern State Bank, which paid a 0.5 percent premium for the deposits and is also purchasing the assets.

Thursday, March 18, 2010

Toyota today sent a four-page letter to ABC News today asking that the network retract its previous story that theorized that faulty electronics were at fault in the unintended acceleration of Toyota and Lexus vehicles. Toyota is also asking for an apology from ABC News. For Toyota, the timing of its request could not be worse. The letter was sent on the same day that new evidence strongly suggests that there is something amiss in Toyota control logic after all.

A new report today from the National Highway Traffic Safety Administration offered this finding from a Toyota Prius that crashed into a stone wall in Harrison, New Jersey: “Information retrieved from the vehicle’s onboard computer systems indicated there was no application of the brakes and the throttle was fully open.”

To Toyota executives, this is proof that the crash was the result of driver error. But this is faulty logic on Toyota’s part. A simpler explanation for what happened in Harrison, an explanation that is also more consistent with other recent experience with Toyota controls, is that the automobile spontaneously stopped reading the controls of the car moments after it was turned on.

From everything we know, the driver in Harrison applied the accelerator, then the brake. The car’s data recorder says that only the accelerator was applied. This is most easily explained if the car stopped receiving valid data from the controls during the time when the accelerator was applied.

It is as if a computer document is suddenly filled with thousands of letter l’s. Did the user decide to press the L key for several minutes, or did the computer keyboard break in the middle of a word? Either is possible, but the hardware failure is more likely. Computer keyboards, if heavily used, tend to fail after just a few years. Most of us have experienced this. The pedals in a modern automobile are digital controls that are not so different from a computer keyboard or mouse, and if there is a design problem with them, they could fail in the same way. After today’s reports, I now believe this is what is happening with the Toyota pedals.

The logic involved in this question is familiar to any computer programmer or recording engineer (or a modern philosopher, for that matter). If box B is receiving bad data from box A, is it because A is sending data incorrectly, or because B is receiving data incorrectly? The logical answer is that it cannot be determined as long as A and B are considered together. They have to be examined separately to learn anything about the nature of the failure (and the two hypotheses I suggested are by no means the only possible explanations). Based on its statements today, this appears to be logic that Toyota has not yet considered.

Wednesday, March 17, 2010

In a fitting irony, the announcement of the new high-speed Internet strategy came at a time when my own Internet connection was down for more than 12 hours, the result of a cable failure. On the surface, high-speed Internet seems like a safer strategy than the status quo. It will not cost a fortune to build, and it will cost less to maintain then the traditional telephone network that it will eventually replace. But it will involve some adjustments that are hard to predict.

One effect that is easy to predict is the importance of hot spots — areas at least the size of a building where Internet access is provided over radio waves, popularly known as wi-fi. The cost of operating a hot spot is already small in comparison to the historical costs of telecommunications. With widespread high-speed Internet access, along with improvements in security software, this cost will fall. There will be hot spots everywhere.

The obvious next step, though, is much harder to predict. The question is this: to what extent could hot spots replace cellular service?

If this question seems a bit far-fetched, consider that this is already happening. My own cellular phone automatically switches between cellular service and wi-fi when it can. It connects me to only about 20 “known” hot spots, and it doesn’t do switch over for voice service, but these are the result of network design decisions, not fundamental limitations.

My guess is that hot spots could replace more than two thirds of cellular service. The frantic construction going on in the cellular business right now could turn out to be the same kind of big mistake that the oceanic fiber-optic cables were in 1998. Enough ocean-floor capacity was put in place in across the Atlantic Ocean that North America could have outsourced all of its computer operations to Ireland. Someday there may be a need for all that capacity, but the haste with which it was put in place, and the indifference of the world after it was brought online, nearly bankrupted the telephone industry, and the excess capacity led to market prices far lower than the industry had envisioned. There is a risk that a similar mistake could be made at this point as the telephone industry tries to stay two steps ahead of the demand for cellular capacity.

Tuesday, March 16, 2010

I wrote yesterday about possible causes for the recent decline in highway crashes. The decline in crashes also has important economic effects: with fewer injuries, there is an improvement in productivity, a decline in health care costs, a decline in the demand for medical services, a decline in disability and life insurance payments, an increase in annuity and retirement payments, an increase in taxes collected, an increase in the size of the work force, and so on.

The lower rate of crashes has surely also affected the pace of auto sales, which also fell off sharply in 2009. Many drivers don’t shop for a new car until the car they have is ruined, an event that didn’t happen as often. This reduces the demand for new and used cars. It also increases the supply of used cars, as more people who buy a car have a car to trade in. This helps to explain why the inventory of used cars did not decline last year even as many car shoppers passed up new cars to buy used ones.

I am not so sure that car crashes will come back when the job market improves and more people are driving to work. Long-term trends in driver skill, traffic reports, automobile instrument panels, and road quality are likely to lead to further reductions in accidents. From this effect alone, about a third of the reduction in car sales we saw in 2009 could be permanent.

Monday, March 15, 2010

The U.S. Department of Transportation released 2009 traffic fatality statistics last week. The numbers indicated the lowest rate of traffic deaths ever. Driving distance also is down from its peak in 2007, so this also means the total number of deaths is down — impressively, down 8.9 percent from the year before. And highway fatalities is a suitable proxy for the seriousness of traffic accidents, so the decline indicates a decline in traffic accidents and injuries.

As you would expect, the Department of Transportation cites its own programs as causing the decline in crashes. However, economic trends may be more important factors. The biggest cause for the decline in traffic accidents, I have to imagine, is the decline in employment. This has made commuting roads less crowded, and when roads are less crowded, it is less likely that one car will collide with another, or will run off the road to avoid a collision with another car.

It seems plausible, also, that the continuing cultural movement away from beer is having an effect on drivers. Beer puts drinkers in an overconfident state in which they are likely to take unnecessary risks — and among alcoholic beverages, beer is more associated with daytime and early evening hours when traffic may be heavier. The Treasury Department reported a 1.1 percent decline in beer from 2008 to 2009, generally consistent with the continuing decline in the prominence of beer since its peak in the late 1990s.

Many other changes also occurred in 2009, including a change in the vehicle mix, with fewer SUVs and more sedans, and a change in consumer sentiment, perhaps putting drivers in a more serious mood. With so many things changing at once, we can only guess at the relative importance of each individual change.

Sunday, March 14, 2010

After appearing to level off at the end of January and again in the second half of February, a change in the weather brought Arctic ice extent roaring back at the beginning of March, running up to a peak only modestly below seasonal average levels around March 4–7. Most of the newly formed ice is in the Pacific Ocean and Baltic Sea, where it will have little effect on the Arctic Ocean. However, ice also solidified in the important boundary areas on the European and Atlantic sides of the Arctic. This new ice could not be much more than half a meter thick, since it formed just a few weeks ago, and is sure to melt away during the spring, but in the meantime, it may protect ice in the area of the North Pole from some of the effects of waves and surface temperatures.

Saturday, March 13, 2010

Imagine being in the position of Greece — of having to prove to the world that your nation isn’t falling apart, that your accounting is on the level, that your people aren’t all a bunch of slackers.

It’s almost impossible to prove that a problem doesn’t exist or isn’t serious, so in the news media, Greece may be stuck with this problem for years.

It’s important to consider this scenario because there is little factual basis for most of the things that are being said about Greece these days. In a matter of a few years, the world could be saying the same things about Ireland . . . about the United Kingdom, California, Texas, and Louisiana . . . about the United States, Germany, and Australia . . . even about China, India, and the Ukraine. Most of the world could be put in the same box that Greece is in now, without the need for any factual change in circumstance.

Where did the current view of Greece as insolvent, with no path forward, come from? If you believe the headlines, the story has its roots in Wall Street. The few facts that are specifically known have to do with Greece’s financial arrangements involving securities that originated on Wall Street.

It’s not hard to imagine that what is really going here is a Wall Street effort to tarnish Greece’s reputation — perhaps to shift the blame, or perhaps just to manipulate markets for profit.

But if merely having ties to Wall Street means that your finances are falling apart, your accounting is fake, and that your people are all a bunch of slackers, then a great many of us may be in trouble before long.

Friday, March 12, 2010

Lehman Brothers used essentially fictitious transactions to disguise its dwindling liquidity in the year before its collapse, according to an explosive examiner’s report that was released yesterday. (Actually, the release was just the first 200 pages of a report that is said to be thousands of pages long.) The report points fingers at JPMorgan Chase and Citigroup, saying that problems there hastened the collapse of Lehman Brothers.

According to reports, Bank of America is resisting regulators’ advice to downsize its operations in order to boost its chances of survival. Bank of America plans to sell some assets it considers redundant, but hints that it wants to continue to expand its operations otherwise.

Bank of Florida announced a $45 million stock offering today, hoping to raise the additional capital by June 30. It lost $145 million last year, and warned in a recent SEC filing that its prospects were doubtful if its stock offering failed.

The FDIC this week extended a transitional safe harbor rule for bank debt securitization that was to have expired March 31. In practical terms, the safe harbor rule allows credit card debt to be sold to investors, which is the way the credit card banks have worked in recent years. When the rule expires, it will be the end of the credit card business as we have known it at least since 2003, and it could bring down a dozen or more large credit card issuers, similar to the way Advanta shut down last year. The new date for the collapse of the credit card industry: September 30.

Florida banking regulators closed Old Southern Bank, which had been in business for just four years in central Florida. The $320 million in deposits and a slightly smaller amount in assets were purchased by Centennial Bank, which is paying a 1 percent premium for the deposits. Centennial Bank’s holding company, Home Bancshares, had raised $100 million in a stock issue for the purpose of acquiring a failed bank. Centennial Bank already had 12 branch locations farther south in Florida, and with this acquisition, it adds 7 in the central part of the state.

Old Southern Bank was founded in 2006, an awkward time for a bank to be entering the real estate market. It started with $60 million in initial capital, but would have needed at least that much more to weather its losses, mostly from loans for commercial real estate projects. It had planned to raise money in a stock offering, but regulators rejected the plan, probably because they thought the terms of the offering were too unfavorable to attract investors.

Louisiana banking regulators closed Statewide Bank. The bank had six locations north of Lake Pontchartrain, in an area significantly damaged by Hurricane Katrina in 2005. The bank had apparently opened and closed several locations since that time. No other Louisiana banks have failed since Hurricane Katrina, partly because the real estate bubble scarcely reached the state. Statewide Bank lost money on commercial real estate loans. It was dogged by purchases of mortgage-backed securities it made in 2006 and 2007, and the sluggish real estate market in southern Louisiana made it hard for the bank to make up its losses with new business.

Home Bank, also of southern Louisiana, is purchasing the assets and assuming the $209 million in deposits.

Two banks failed in New York City:

The Park Avenue Bank, with four offices and $495 million in deposits. The failure was not unexpected, after an affiliated investment company which funded more than 10 percent of the bank’s loans filed suit last week in an effort to stop the bank from settling some of its failed loans. Observers saw the lawsuit as an attempt to slow down an expected FDIC liquidation. The bank’s net worth had gone negative in its latest financial statements, so only a well-funded buyout could have saved the bank from being seized and liquidated. The bank appeared to be in over its head in a web of real estate development intrigue. (The Park Avenue Bank is not related to a larger bank by the same name in Georgia and Florida, which was also in the news this week. It announced a $85 million stock offering this week and is in the process of selling off 5 branches to improve its capital position.)

LibertyPointe Bank, with three offices. It was closed last night in an unusual Thursday night bank closing. The failed bank had $209 million in deposits as of December 31 and a similar amount in assets.

The successor for both banks is New Jersey-based Valley National Bank, which paid a 0.15 percent premium for the deposits and purchased all the assets. Valley National Bank already had around 200 branches in New Jersey and New York.

There was a credit union failure a week ago, Lawrence County School Employees Federal Credit Union, of Lawrence County, Pennsylvania, which had a thousand members and $3 million in assets. The credit union’s membership had fallen by almost half, partly because of reports about its financial condition, and partly because of local layoffs. First Choice Federal Credit Union took over part of the membership accounts, with the NCUA taking charge of the rest. First Choice did not hire any of the employees of the failed credit union.

Thursday, March 11, 2010

The focus of the recent discussion on a financial consumer protection agency suggests that the idea of financial consumer protection may still be too radical for Washington.

Placing this agency in the Treasury Department would create an obvious conflict of interest. The focus of the Treasury Department is obvious enough from its name. Its interest in the people’s money mainly has to do with finding ways to get the people’s money into the national treasury. That’s the way you’d want a treasury to work, but it’s not exactly consistent with the goal of protecting consumers.

Equally obvious conflicts can be found in alternative suggestions for placing the agency in the Fed or the FDIC. Worse, the task of consumer protection would weaken the focus of these agencies on their very important primary missions.

The reason politicians want to gut the proposed financial consumer protection agency by placing it in a position of inherent conflict is that they are afraid of what an independent agency charged with financial consumer protection might do. It could be the end of “gotcha” banking, the current scheme in which the biggest share of bank revenue comes from fees that the customers don’t expect. And if that could change, what else could change?

Wednesday, March 10, 2010

There is little doubt that this year will see a new record in home foreclosures and evictions, but some are predicting a burst in short sales that could put a dent in the foreclosure rate.

In a short sale, the lender agrees to sell the house at its market value and take all the money in lieu of mortgage payments, even though the market value is less than the amount of the loan. Short sales are traditionally rare just because banks usually try to avoid lending more than the value of a house, but in areas where home values have fallen by more than 25 percent, they may be the only option left for homeowners who are forced to move. Historically, households move about every five years, and the slow economy cannot slow that down forever, even though it means losses for homeowners and lenders. Short sales may be boosted somewhat this year by a federal program that will essentially pay closing costs for qualifying short sales.

But I think banks’ distrust of borrowers will keep the pace of short sales somewhat muted, though it still will surely set a new record. Banks and mortgage investors tend to feel they are being cheated in a short sale, even though the borrower, who also has to spend money to make the short sale happen, walks away with nothing.

With this basic suspicion of short sales, many of the larger banks are telling borrowers that they aren’t willing to discuss a short sale. Of course, every bank has to prefer a short sale to a foreclosure. The bank can save $20,000 in administrative fees, and stands a chance of selling the house sooner and at a higher price. Because of their suspicions, however, some banks won’t discuss a short sale until it is too late for it to be of much help. The borrower may stop making payments and move to a new job in another city, and the bank may still wait for months before agreeing to a short sale. By then, the potential savings that might have come from a short sale have mostly evaporated. The bank, at that point, might as well foreclose.

Eventually, lenders will have to realize that it is to their advantage to move quicker when employment considerations force a borrower to move away. I believe they will at least assign lending specialists to respond immediately to change-of-address letters. Given the current atmosphere in banking, however, I do not expect much movement in that direction this year, at least at the larger banks. Recent history has shown that it can take three quarters of financial results for banks to understand where their financial interests lie, and the foreclosure process itself can take a year. Given that lag, some of the larger could still be pushing back against short sales at the end of next year.

Short sales are good for communities because they reduce the number and duration of home vacancies related to foreclosures. But by moving distressed homes onto the market faster, they add to the downward pressure on home values. Only a further decline in new home construction will allow home prices to stabilize, and that cannot happen as long as home prices remain artificially high.

Tuesday, March 9, 2010

I’ve noticed this year a lot of well-informed observers, including economists who should know better, looking at the economy and saying, in effect, “As soon as we can get the banks lending again and the builders building again, the whole economy can come roaring back.”

The truth is, banks are lending. But lending to real estate developers? Why would a bank want to do that? Every week you hear about a bank being sued by an insolvent developer whose projects went spectacularly over budget and failed, and who is seemingly weeks away from bankruptcy. And it’s not just that a lot of real estate developers can’t draw up a budget to save their lives. There’s a reason they’ve been squeezing their budgets in the last five years. It has been getting harder and harder — often just impossible — to get a commercial real estate project’s budget to work out because there is such a glut of commercial real estate already.

The orgy of building that fueled the last sputtering years of the recent expansion was a mistake. There is no reason to imagine that it should come right back. There is no economic imperative to force anyone to keep building office buildings and shopping malls at a loss. It’s entirely possible that there could be a 15-year pause.

I do realize that building has led the U.S. economy out of recessions before. But those recessions were not created a real estate bust. Historically, the sector that causes a bust is almost never the one to lead the economy in the next expansion. Especially now — we can’t wait 15 years for the builders to come back. The expansion has to come from somewhere else.

Monday, March 8, 2010

It finally happened. A major television broadcaster cut off a major television cable system because of a dispute over programming fees.

The broadcaster in this case is ABC, and the cable system is Cablevision, but the details scarcely matter. The same dispute could just as easily involve 50 other companies in the television business before the year is over.

The dispute doesn’t really make sense in the first place. There ordinarily shouldn’t be any money changing hands between television broadcasters and the companies that distribute television content on cable and satellite systems.

Broadcasters get paid more than enough money by advertisers to produce all the programming they produce. Around 30 percent of air time is taken up with these commercial messages. Cable companies also get paid by advertisers for the two to four minutes an hour that the cable systems get to run their own commercials on cable channels. This is roughly enough advertising money to cover the cable operator’s costs in obtaining and delivering the signal for the channel.

So who should pay money to whom? In an ideal world, neither company should be paying anything to the other.

Yet for several years, broadcasters have been squeezing cable operators to try to get more money in so-called programming fees. Money that supposedly goes to produce the programming on the broadcast channels. Never mind that the programming has already been more than paid for by the advertising that comes along with it. Never mind that all these fees are ultimately paid for by the television subscribers.

Television has already lost millions of viewers because of the high cost of television subscriptions, and it will lose millions more if this trend continues. Households that are willing to pay $200 a month for cable this year may decide to cancel next year when the price goes up to $250 a month. Of course, as viewership declines, advertising revenue will decline, and broadcasters will be back asking for still more money, leading to more canceled subscriptions, in a death spiral that can’t possibly come out well for the television industry.

The only possible solution that will hold the television industry together is a phase-out of programming fees for commercial stations and channels, with a strict cap on fees paid to non-commercial broadcasters.

Broadcasters won’t like it, but at this point, they have only two options: phase out the fees, or phase out the audience. I believe that phasing out programming fees is the less drastic alternative.

Saturday, March 6, 2010

One of the biggest news stories this morning said that the Pentagon would be looking into allegations of a pattern of misconduct by one of its major contractors in the war in Afghanistan. There has been credible evidence for years that this contractor has been improperly diverting supplies and equipment intended for particular uses, and using them for its own benefit. There are also reasons to question whether the contractor is qualified to do the work that the Pentagon has been paying it to do. For years the Pentagon was content to look the other way and hope for the best. Now, apparently, that is changing.

Supposedly the inquiry is being done at the request of a senator, but my hunch is that the real story is that the White House Chief of Staff, or someone like that, called up the Pentagon and starting asking questions, in a conversation that might have gone something like this: “Well, is it true that this contractor has been stealing stuff from the government in Afghanistan, or not? — What do you mean, you don’t know? — Well, don’t you think you’d better look into it?”

If my hunch is approximately correct, this could be a watershed moment for the Pentagon. The chief concern there in recent years seems to have been the spoils of war, obtained not from the “enemy,” who can scarcely be identified, but from the Pentagon’s ever-growing share of the federal budget. Now perhaps there is a shift in emphasis to focus more on effectiveness. What other conclusion can you draw from an organization that for years couldn’t be bothered to check whether hundreds of billions of dollars was being spent well, now suddenly investigating allegations of corruption that may involve one billion dollars or less?

I hope this is the case, anyway. War should never be undertaken with an eye on corporate profits, but only to save a group of people from a fate considerably worse than war. The United States went into Afghanistan to save the country from starvation at the hands of a brutal regime that had gone to great lengths to wipe out agriculture there, but that objective was achieved in a matter of months. The reasons for the continued U.S. presence there, in what could easily become the longest war in U.S. history, are much harder to explain. When anything lasts as long as this war has, you have to look at the profit motives involved. When profit can be taken out of war, peace can come with surprising speed.

Friday, March 5, 2010

The bankruptcy trustee for Thornburg Mortgage has filed suit against four executives and their lawyer, claiming that the executives paid themselves bonuses after they knew their company was going bankrupt and used the money to fund a new competing company using a business plan taken from the failed lender. If the defendants knew their company was going bankrupt, all of these actions would be improper unless approved by the bankruptcy judge. The suit further alleges that thousands of dollars were paid from the failed company to suppliers for actions they took on behalf of the new startup. This kind of legal filing is routine in business bankruptcies, as the bankruptcy court is obliged to try to recover any money spent “in view of” bankruptcy in order to distribute the money to the company’s creditors. Thornburg Mortgage, before it went bust, was one of the largest jumbo mortgage lenders, and its bankruptcy was one of the largest bankruptcies last year.

Under new rules, European banks are not allowed to take loans off their books by purchasing credit default swaps, but a delayed transition is keeping several hundred billion dollars in these swaps active on AIG’s books. AIG is hoping to wind down its derivatives business by the end of this year, if the company lasts that long, but it now seems likely to still have some of these contracts active into next year. AIG’s derivatives business, once estimated at over a quadrillion dollars, if that’s possible, has been winding down and running off, and now may amount to “just” one to two trillion dollars — still a treacherous burden for a company whose market value has shrunk to $3 billion.

AIG has agreed to sell its struggling Asian life insurance unit, AIA, and according to sources, it is also close to selling its international life insurance unit, Alico. The two sales bring in about $30 billion in cash, but will leave AIG a shell of a company, with only a few small profitable divisions surrounded by dozens of divisions that apparently, if the transactions between the divisions are taken away, have been losing money for years.

The TARP fund is taking an estimated $70 million loss on its investment in Chicago-area bank Midwest Bank and Trust Company. Despite government help, the bank’s market value has fallen to $10 million, a 96 percent decline from its 2008 peak, meaning investors don’t hold much hope of it surviving its current troubles.

The First Niagara acquisition of Harleysville National Bank has been approved by stockholders, and the transition plan is well underway, but so far, the deal has not been approved by the Fed. The Fed reviews all mergers of bank holding companies to assure that the resulting company will be financially strong enough to function as a bank holding company. Dozens of bank failures in the past 15 months have resulted after the Fed has disapproved a merger plan, and there are reasons to wonder whether this could happen to Harleysville National Bank. First Niagara, though, is confident enough that is has purchased new First Niagara signs for all the Harleysville National Bank branches on the assumption that regulatory approval will come through by April 4. If it’s right, the Harleysville logo will disappear on the weekend of April 9.

At the top of the list of tonight’s bank failures is Sun American Bank. This bank, with 12 locations in southeast Florida and $444 in deposits, operated under several names during its short 23-year history: originally Florida First International Bank, then Southern Security Bank. In 2001 it acquired Pan American Bank and took on that name. A 2003 buyout changed the name to Sun American Bank. A series of acquisitions followed, and the bank never really recovered from those acquisitions. Its financial reports have declined quarter by quarter over the past three years, and its stock has tumbled during that time, losing 99 percent of its value and eventually leading Nasdaq to delist the stock at the end of last year. The Fed at that point issued a prompt corrective action with a February 5 deadline.

The locations, assets, and deposits are being transferred to North Carolina-based First Citizens Bank. First Citizens Bank previously acquired three other failed banks, all outside its core territory between Tennessee and Virginia.

In Utah, Centennial Bank failed tonight. Northern Utah has a plethora of banks, so the FDIC could not find a bank interested in taking over the failed bank’s 5 locations. Of the bank’s $205 million in deposits, approximately 99 percent were within the deposit insurance limits, and the FDIC will mail checks to the depositors beginning Monday. Zions First National Bank will accept direct deposits sent to Centennial Bank accounts for the next few weeks on behalf of the FDIC.

Centennial Bank was created in 1997 by local investors specifically for the purpose of making construction loans and other real estate development loans in Utah. The Utah real estate market has declined more than other areas of the country, so Utah real estate hasn’t been a favorable niche for a bank in recent years.

Bank of Illinois was the latest in a series of bank failures in that state. It was based in Normal, a suburb of Bloomington, in central Illinois, and had two offices and nearly $200 million in deposits. Heartland Bank and Trust Company is purchasing the deposits and assets, paying a 3.6 percent premium for the deposits.

The final nail in Bank of Illinois’ coffin apparently came in a legal tussle between the bank and a failed local real estate developer who was in default on $9 million in loans. The apparent cosigners for part of the loans filed legal papers two weeks ago saying that they had not cosigned the loans, and that the signatures on the documents were forged. Within days, the bank filed suit against the investors, claiming that the documents could not have been forged, although it could not say exactly how the documents came to be signed, as the investors had apparently never visited the bank’s offices. Based on its statements, the bank did not have clear procedures for obtaining signatures on loan documents, so it seems plausible that a bank employee or someone associated with the borrower could have added the signatures improperly. Needless to say, this kind of problem does not make a good impression on bank regulators, and may have encouraged the state to close the bank more quickly.

The final bank failure to report tonight is, to be blunt about it, a mystery. The bank is Waterfield Bank, which had its headquarters in Germantown, Maryland, in the Washington, D.C., metro area, although its operations, mailing address, and telephone number were in Irvine, California. The bank had been owned by Affinity Financial Corporation for only about two years. The bank had little former history, being founded in 2000 by an insurance organization and reorganized twice since that time. The bank apparently never had a profitable quarter, and its capital ratio went negative at the end of 2009. Around the time of its purchase by Affinity Financial, the bank purchased $125 million in mortgage-backed securities, amounting to nearly half its assets, a highly unusual transaction for a small bank.

Affinity Financial, for its part, is an intentionally mysterious organization, as its main emphasis is “private label” banking. This arrangement is supposed to allow membership organizations, apparently including AARP and American Medical Association, to give the appearance of having their own bank, with the banking actually provided by the banks of Affinity Financial. It is understandable that a private label banking operation would want to obscure its identity somewhat, yet in everything I could find out about Affinity Financial, it goes to astonishing lengths to obscure its true operational structure. Looking at the story it offers about itself reminded me, in an uneasy way, of Stanford International Group, which was seized a year ago for running an apparent Ponzi scheme. I must hasten to add that I have no evidence of anything improper in the operations of Affinity Financial, but as in the case of Stanford, its web sites and other public documents offer a great deal of puffery but surprisingly little substantial information that would allow a person to conclude that it is a legitimate banking business. An example from the failed bank’s web site, complete with grammatical error:

Waterfield Bank is a Waterfield Family Company. Waterfield Group is one of the largest private financial services organization in the United States.

The description does not correspond well with the FDIC’s report that the failed bank had $156 million in deposits — that would make it a bank of only average size. Other errors in the web sites include a claimed association with “Blue Cross Blue Shield,” which is not the name of any one company. This kind of error raises a red flag, as it suggests that Affinity Financial does not want potential customers to be able to verify its claims.

As I said, this bank failure is a mystery, and I will see what more I can find out about it.

The FDIC has set up a bridge bank to handle the failed bank’s checking and savings accounts. The bridge bank will operate for 30 days to give customers time to move their accounts to other banks, but customers should start immediately on Monday to make other banking arrangements. CD and IRA accounts are not being transferred to the bridge bank, and based on the bank’s business model, those were probably the vast majority of deposits. The FDIC will mail checks to those account holders beginning Monday. Because of the bank’s private label banking approach, customers may not realize they held accounts with the bank until they receive the checks in the mail.

Thursday, March 4, 2010

It’s the hardest thing to understand about the U.S. economy: why there hasn’t yet been any serious attention paid to the problems of the financial system and the changes needed in the rules it operates under. It’s not that there hasn’t been time. Many people saw the need for reforms in 2005. By 2006, the need for change had become so obvious that bills in the House of Representatives were referred to committee for study. And the financial system’s troubles and shortcomings have only become more obvious in the years since. Yet the simplest reforms have not yet been made.

Lawrence Lessig wrote today that the problem is “Systemic Denial” — at a conference yesterday, “Expert after expert spoke as if the problems we faced were simple math errors” rather than the more serious errors we see in business models, management, government oversight, and ultimately, governance.

The consensus of experts seems to agree with the White House line that we have stepped back from the precipice, when a more accurate depiction would be that we have dropped some rocks over the edge, and are a in position to drop more and perhaps fall over the edge ourselves.

A big part of the problem comes from taking the financial infrastructure for granted. Few, if any, of our great financial institutions are run by people who understand how they work. Worse, government regulators and investors seem to think this state of affairs is acceptable. Perhaps in calmer times it might be tolerable, but at this point, the risk it poses to the economy is enormous.

No expertise is required to be a bank CEO, but that doesn’t excuse bank executives from being held accountable for the mistakes they make. Regulators have forced out perhaps 20 bank executives in the past two years for having a pattern of making stupid mistakes that put their banks at risk, but in most of those cases, there were issues of corruption involved as well — and in most of those cases, the banks in question failed, or are well on their way to doing so.

So that is the right idea, but it is not nearly enough. Boards of directors should be removing executives who have a pattern of mistakes of incompetence. In some cases, where the actions are not mere mistakes, prosecutors should be taking action. Stockholders should be removing directors who don’t understand the businesses they are overseeing.

Alas, very little of this is realistically going to occur. And so the risk remains great. The only realistic prospect for protecting the economy is to keep institutional power from becoming too large — and roughly fifty large financial institutions are already too large.

A set of strict break-up-the-banks rules would create too much concentrated power in the hands of the politicians and bureaucrats who would design and implement the rules. I don’t want to see that happen, but I also don’t want to see rules so flexible that Wall Street can find a way around them. That still gives us plenty of options, though. These are the kinds of rules that I think would address the problem of institutions that have become too large:

A merger tax. There could be a very simple tax, perhaps 1/2 percent of assets, on both corporations involved in any corporate merger or buyout. This tax would have to be paid before any merger could be finalized. This tax, obviously, would discourage very large companies from merging into still larger companies, but it would fall less heavily on smaller companies.

A tax on leveraged buyouts. Leveraged buyouts have set up many of the spectacular bankruptcies of the last three years. There ought to be a tax that reflects the costs of those bankruptcies and, in addition, some of the economic costs that result from the concentration of power found in the resulting corporations. I would suggest a tax of 20 percent on all money borrowed for any corporate buyout. To avoid loopholes, this tax would also have to apply to advisory, management, transaction, and other fees associated with the leveraged buyout. I realize that Wall Street, which is used to not paying taxes, will think this an extraordinarily stiff tax. I would remind them that the personal income tax rate is higher than this.

Higher reserve requirements for large banks. There is no mistaking the tendency of the largest banks to be involved in casino-style activities that put the banking system as a whole at risk. That tendency has increased markedly since 2008 because of the financial pressure on these banks. To compensate for this risk, I would suggest that for any bank holding company whose total assets are greater than 1 percent of the country’s total insured deposits, the reserve requirement ought to be based on total assets, rather than on deposits. Further, to the extent that the assets are greater than this threshold, the reserve requirement rate should be doubled. This allows banks to be extraordinarily large if there is a compelling business reason for them to do so, but it prevents the large banks from ruining the whole banking system by taking everyday banking business away from the real banks.

Changes such as these wouldn’t cause any undue hardships, and if phased in over two or three years, they wouldn’t require any uncomfortable adjustments. Yet they could go as far as we need to go toward reducing the threat posed by a top-heavy financial system.

Finally, as always, I have to mention the urgent need to make derivative contracts public. No one can make the claim that we are getting a handle on the problems of the financial system — indeed, we do not even know the scale or character of the problems we face — as long as derivatives are allowed to be traded in secret.

Wednesday, March 3, 2010

The White House’s January proposal for a new nuclear power station makes more sense in the light of the talk this week about decommissioning another part of the United States’ nuclear weapons. The nuclear materials taken from the weapons would be sufficient to launch one nuclear power station and fuel it for many years.

Yet I still fear this is a miscalculation. There is not enough uranium in the United States to fuel the nuclear power stations that already exist for their expected service lives, and the situation in Europe is worse. Eventually, the world will likely be forced to decommission all its nuclear weapons, but even this will buy us only a few more years of electricity.

It is better in the long run to save whatever nuclear materials we can find for the existing nuclear power stations, and to begin building now the power sources that will supply us after the world’s uranium is exhausted.

Tuesday, March 2, 2010

The really troubling thing about this loss is that it occurred in a quarter when the stock market was rising. During the previous two quarters, stock market gains had been sufficient for AIG’s insurance divisions to report a profit. But that was during the most rapid increase in the history of the stock market — a stock market bubble. If it takes a stock market bubble for a company to break even, it is fair to say that the company is losing money in its operations. Worse, this has probably been the case for years at AIG’s insurance companies, and was likely the underlying stress that led AIG executives to undertake their trillion-dollar gambles in the derivatives market.

And if this is the case, then the ongoing effort to spin off or otherwise save AIG’s insurance divisions is a fool’s errand. They cannot be spun off if they cannot stand without subsidies. They cannot ultimately survive in any form while continuing to lose billions of dollars year after year.

This is especially the case when you look at what will be left of AIG after the sale of AIA, AIG’s Asian life insurance operation. AIA is as close to the heart of AIG as you can get, and the only large operating company in AIG that was possibly still breaking even. Even with AIA, the best chance to keep AIG going was the Wall Street equivalent of casino gambling; without AIA, there is no other course of action.

AIG’s financial statements contained the warning that the company might run out of money and need to seek additional outside funding, presumably again from the Treasury. Even with the $25 billion from the AIA sale, that day may come soon — $25 billion might sound like a lot of money, and it is, but it is not enough for AIG to withstand the next downturn in the stock market. AIG says its entanglement with the world’s large banks has been reduced by an order of magnitude from its peak less than two years ago, and even at its peak, it never posed a systemic risk to the broader economy, though perhaps Goldman Sachs and General Motors were at risk. If AIG does come calling for more money as Wall Street’s fortunes sag in the coming weeks, perhaps the Treasury can be persuaded to allow the company to wind up its affairs with the dignity of a proper liquidation in bankruptcy court.

Monday, March 1, 2010

The U.S. GDP numbers for the fourth quarter were revised up to an annualized rate of nearly 6 percent, but in reporting this, the news media is barely taking a breath before adding that this rapid growth rate can’t last.

How can they be so sure? If you look inside the numbers, you find that the impressive increase in manufacturing is matched by an increase in inventories. As the news stories gently put it, retailers and wholesalers are “replenishing” inventories.

It makes it sound as if the warehouses were empty. But while that is surely true in a few isolated cases, the story when you look at the aggregates is very different.

Inventory levels at the beginning of the last quarter were already far higher than you could justify for the level of economic activity that was taking place. By the end of the quarter, inventories had risen to bubble levels. You cannot justify inventories this large even if you believe that bubble-level spending will return in 2010. And that is extremely far-fetched notion; other indicators suggest that business spending will barely increase this year, and consumer spending is more likely to decline again than to increase.

So this means that businesses were not “replenishing” inventories so much as adding to already bloated inventories — in a word, hoarding.

The reason we know this can’t last is that hoarding is as expensive in business as it is at home. And businesses are more keenly aware of their expenses. Rent, labor, lighting, supplies, insurance, and the other expenses that go with keeping an inventory are tallied and compared to the business’s plan and objectives. Accountants, these days, look over the numbers asking, “Where can we cut back?” Lenders, analysts, and investors study them too, asking, “Is this company well managed?” All this scrutiny tends to lead a business that is hoarding to suspend its purchases until it restores a degree of equilibrium in its operations.

In this way, the hoarding of the fourth quarter could easily turn into the purchasing freeze of the first quarter, as businesses slow down their buying to try to get inventory levels back into balance. In the worst case, the 6 percent (annualized) increase in the fourth quarter could turn into a 12 percent (annualized) decrease in the first quarter. That is what could happen if businesses abruptly returned inventories to the levels of the beginning of the fourth quarter.

I do not expect that to happen, but there are great many other things weighing on the economy in the current quarter, among them, continuing job losses, especially in local government, a decline in consumer activity, and the effects of unfavorable weather across most of the country, destroying crops in Florida and keeping commuters at home in New Jersey. The negatives are well known, the positives more mysterious, but it is hard to imagine that the hoarding effect will be strong enough to lead to another quarter of GDP growth.